In this interview, Stefan Bosshard, Product Head for Fixed Income at SDX, gives a deeper insight into the issuance structure and process, its significance for digital asset markets, and his views on the future of digital assets.
In November 2021, SDX achieved a world-first: the issuance of a digital bond on a fully regulated, DLT-based exchange and central securities depository (CSD) environment. Furthermore, the issuance was open to a range of investors, and the entire process is fully replicable. The issuance gave investors – including insurance companies, pension funds and asset managers – a taste of the future, allowing them to gain exposure to digital assets in a reduced-risk environment.
Hi Stefan! Who was the issuer behind this digital bond, and what benefits did they gain from tokenization, in contrast to a traditional bond issuance?
The issuer behind this digital bond was the SIX Group’s own Treasury Department. This made sense for various financing reasons: we had acquired the Spanish Stock Exchange last year and wanted to undertake a debt issuance for this and other purposes.
Superficially, at this moment in time, there are not a lot of obvious benefits to the issuer compared to a traditional issuance. But, on the other hand, there weren’t any downsides either, due to how we had structured it! Therefore, we demonstrated the viability of a digital bond issuance, which was an important point to prove and the potential of the technology behind it.
In the future, of course, as the technology and the ecosystem around digital assets develop and evolve, digital issuances will bring many tangible benefits. The issuance process itself will become more efficient and the asset servicing throughout the instrument life cycle. Smart contracts also open up more opportunities for automation. The prospectus, for example, is at present a heavy physical, legal document. As we translate more and more of the prospectus into code within the asset itself, the market will become more efficient, and the costs of servicing assets – and hence the costs of accessing funding – will be lower for issuers.
Last November’s bond issuance had a very interesting structure – it was partly issued, traded and held in digital form on the SDX exchange and CSD infrastructure and partly in a traditional form on the parent SIX exchange and CSD. What was the reasoning behind this?
That’s an excellent question! While we’ve introduced digital assets and built a new regulated exchange and a new regulated central securities depositary (CSD) for trading and settling them, we are very much aware that not all investors are operationally ready or entirely comfortable with the first issuance. We wanted to give these investors the opportunity to participate in the issuance through whatever form of the asset they are most comfortable with. It means that our pool of potential investors is bigger, as it includes both traditional and digital investors, which is good for the issuer. By doing this, we’re eliminating the placement risk associated with a purely digital issuance and also ensuring that funding costs for the issuer aren’t negatively impacted, as the issuer doesn’t need to pay a higher coupon or higher yield to investors in the digital bond to incentivize them.
It was definitely a challenge to implement this dual structure in the prospectus, but worth the effort. While they have the same risk and economic profile and value, these are two separate bonds, both technically and legally. They’re two separate bonds, with two separate ISINs and two separate registries; plus, given that one is traditional and the other is digital, there are also two separate CSDs. We do, however, have an exchangeability feature in place, which means that an investor can transfer, almost frictionlessly, between the two forms of the bond. One of the banks involved in the issuance acts as a conversion agent, guaranteeing that an investor can switch from one to the other.
The two bonds are also not fixed in size so that demand can drive the number of outstanding bonds for each part of the issuance. We were very positively surprised to see that the digital part had almost twice as much take-up as the traditional one, as we had expected it to be the other way round! Hopefully, in the future, we’ll also see more investors switching to the digital bond as they become more confident and develop their operational capabilities to support it.
What types of investors did the issuance attract – were they primarily institutional, or were there also retail investors participating?
We can’t share the exact nature or breakdown of the investors in this issuance for legal reasons. However, issuances of this nature are typically taken up by institutional investors. It is also possible for retail investors to participate – they can place an order with their desk at their house bank, which will collate internal and external orders and become part of the allocation process. It’s likely, therefore, that we had retail investors participating. In this instance, due to regulatory restrictions, we were also limited to Swiss domestic investors.
On the secondary market, we are also looking to members of the exchange to stimulate liquidity in the issuance by acting as market makers, liquidity providers and brokers. We’ve currently got three major Swiss banks on-boarded to the SDX exchange, all of which were involved in the digital bond issuance process and all of which are now providing prices – and therefore liquidity – from their trading desks. And so, there are also opportunities for both institutional and retail investors to participate in the secondary market.
Given that economically and with respect to their risk profile, they are designed to be identical, what’s the primary difference between the digital and traditional bonds in this issuance?
The digital bond and its supporting digital market infrastructure (the exchange and the CSD) are built on distributed ledger technology (DLT). This enables us to implement something unique to digital assets: atomic settlement, meaning that you also settle as soon as you trade. The atomic settlement eliminates counterparty exposure and risk since the delivery and payment legs of the transaction occur simultaneously. It does also have broader ramifications for markets and trading practices. For example, it is not possible to borrow or lend between the trade date and settlement date since there is no latency between the two. This means that a participant trading on the exchange must hold the asset they intend to exchange.
While digital assets have the potential to be continuously traded 24/7, we don’t do that at present, as we don’t want our operations staff to be working 24/7 when there isn’t that 24/7 demand! As the network of liquidity pools grows globally, this will become more relevant in the future.
What about green bonds – are they particularly well-suited to tokenization? What unique benefits can digitization and tokenization bring for ESG and green finance?
Green bonds, or ESG bonds, are very dear to my heart. As an infrastructure provider, we’re always thinking about where we can add value, as this is such a huge and growing market at the moment and one that we see as very important in the future of financial markets. Greenwashing is also a huge issue. We believe that technology has a significant role in developing effective green bond markets, especially when it comes to tokenization and the use of smart contracts to govern green digital bonds. Using technology in this way can significantly ease the burden for issuers when it comes to reporting against metrics in the prospectus and demonstrating the impact of an investment. For example, we can design the asset so that the development of the issuers’ investments – funded through that bond – can be automatically tracked and reported in terms of CO2 issuance or other metrics. In this example, we could even build a smart contract that can automatically raise or lower the interest rate or bond coupon depending on the CO2 output. There are many more possibilities out there!
SDX has now proven the concept of a fully regulated digital bond issuance. So why did you choose to start with fixed income, and what’s next in asset classes and tokenization?
As an instrument, bonds are relatively easy to understand, but they can have very complex structures. By digitizing the instrument, we’re already adding much value and reducing the cost and overhead of issuance. This makes the benefits of tokenization and automation more visible to both issuers and investors, as opposed to listed equities, which are already very standardized and liquid. We started with vanilla bonds so that investors can familiarize themselves with digital assets, and then we can move on to more complex bonds. It is possible to tokenize equities, and we have both the license and the technology for that. Naturally, it’s easier to build out the capabilities for asset classes – namely equities and bonds – that are currently supported by our exchange and CSD. That said, we are constantly in discussions with market participants interested in tokenizing other types of assets. Non-traditional investments such as art and real estate are very much of interest and ways in which the value of other balance sheet assets can be unlocked. We have not yet fully defined what will come next in this space!